Bridging the Gap: Global Listed Infrastructure

Beyond Bulls & Bears

Sep. 26, 2013, 7:11 PM

Simply spreading your investments across a smattering of asset classes with the idea that diversification should automatically produce a positive result is an approach that's maybe a little too similar to a roll of the dice. A portfolio of poorly performing investments may be diversified, but it's not necessarily a path to higher risk-adjusted returns or to the sort of stability one might hope could survive bouts of volatility. For investors hunting for classes to diversify into, Wilson Magee, Director of Global Real Estate and Infrastructure Securities, Franklin Templeton Real Asset Advisors, and co-manager of Franklin Global Listed Infrastructure Fund, has one word: infrastructure.

Global listed infrastructure focuses on assets that provide essential services which are necessary for populations and economies to function, prosper and grow. The asset class invests in transportation such as rail, airports (but typically not aircraft), water utilities, electricity utilities, communications infrastructure (for example, cell phone towers), toll roads and ports. Infrastructure includes essential energy services, such as transport and storage but not exploration and production.

Playing Defense

We think one of the most attractive potential benefits of global listed infrastructure is its relatively stable revenue streams, a feature that has become particularly appealing to volatility-weary investors. Coupled with an attractive historical dividend yield, this asset class demonstrates underlying defensiveness in cash flows. Part of the appeal of the asset class stems from the essential nature of the assets themselves, which have relatively monopolistic and regulated positions, high barriers to entry, stable demand and long duration assets with defined revenue streams. Such characteristics can provide the asset class with a degree of protection from the business and economic cycles that is not available to equities. This is why, we think, we've seen infrastructure investments deliver continued earnings growth and stability during the course of the global financial crisis.

Global Growth

We believe global listed infrastructure as an asset class is poised for strong growth. Three important growth themes for infrastructure worldwide support this view. The first is aging infrastructure, which in many developed markets needs to be repaired, replaced, or upgraded. One estimate suggests that by 2020 the US needs to spend US$3.6 trillion1 to repair aging infrastructure, and globally the estimates are closer to US$57 trillion2.

The second growth-supporting theme is global population growth, particularly in emerging markets where urbanization and an expanding middle class are likely to drive rapid growth in demand for new infrastructure. Globally, the middle class is expected to grow by 800 million people from 2005 through 20153. From 2015 through 2025, another 1.5 billion people are expected to be added to the middle class4. A rising middle class will require infrastructure to support the increased demand for essential services and transportation of goods and products.

And third, with a combination of increased fiscal spending and economic distress, a significant gap in government infrastructure spending could occur during the next 20 years in both the developed and emerging markets. In our view, this could create an enormous potential opportunity for private listed infrastructure investment.

These growth themes indicate to us that prospects for global listed infrastructure investment look promising, and the asset class looks attractive when compared with other asset classes, such as global equities generally, US equities, and bonds.

Don't Forget Dividends

An important component of the global listed infrastructure asset class has been a history of dividends. As represented in the chart below, the annualized dividend yields for the period ending 6/30/13 for infrastructure companies compares favorably to those of some other asset classes5.

Historically, dividend growth has also outpaced inflation,6 having grown annually over the last 10 years7, and the compound growth rate of 11.3%8 annually has easily outpaced inflation. However, we do not expect dividend growth rates in the future to be as high as it has been in the past. Long-term inflation-linked contracts are a frequent characteristic of many infrastructure investments, often supporting both dividend stability and growth.

Here, and There, and There, and There

In our view, investors looking for diversification will find that global listed infrastructure can provide a diversified source of income, as well as attractive growth potential. While diversification doesn't guarantee profit or protect against loss, infrastructure as an asset class offers global opportunities spanning North America, Europe, Asia Pacific and Latin America. We are particularly enthusiastic about the prospects for US energy infrastructure and for Latin America, where we expect significant growth could be possible.

Regardless of where the opportunity is, we believe a bottom-up stock selection process is paramount to long-term investment success and that infrastructure can provide investors looking for both potential income and appreciation an attractive solution.

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What Are the Risks?

All investments involve risks, including possible loss of principal. The Franklin Global Listed Infrastructure Fund's investments in infrastructure-related securities involve special risks, such as high interest costs, high leverage and increased susceptibility to adverse economic or regulatory developments affecting the sector. The fund's investments in utility company securities, if purchased for dividend yield, involve additional interest rate risks.

When interest rates have risen, the stock prices of these companies have tended to fall. Thus, as the prices of utility company stocks in the fund adjust to a rise in interest rates, the fund's share price may decline. By focusing on an industry or group of industries, the fund carries much greater risk of adverse developments and price movements in such industries than a fund that invests in a wider variety of industries. Special risks are associated with foreign investing, including currency rate fluctuations, economic instability and political developments. The risks of foreign investing may be greater in developing or emerging markets. Investors should be comfortable with fluctuations in the value of their investment, as small and mid-sized- company stocks can be volatile, especially over the short term.

Smaller or relatively new or unseasoned companies can be particularly sensitive to changing economic conditions, and their prospects for growth are less certain than those of larger, more established companies. Derivatives, including currency management strategies, involve costs and can create economic leverage in the portfolio which may result in significant volatility and cause the fund to participate in losses (as well as enable gains) on an amount that exceeds the fund's initial investment. The fund may not achieve the anticipated benefits, and may realize losses when a counterparty fails to perform as promised. These and other risks are described more fully in the fund's prospectus.